NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Banks, Liquidity Management and Monetary Policy

Javier Bianchi, Saki Bigio

NBER Working Paper No. 20490
Issued in September 2014, Revised in July 2020
NBER Program(s):Economic Fluctuations and Growth, International Finance and Macroeconomics, Monetary Economics

We develop a tractable model of banks' liquidity management and the credit channel of monetary policy. Banks finance loans by issuing demand deposits. Loans are illiquid, and transfers of deposits across banks must be settled with reserves in a frictional over the counter market. To mitigate the risk of large withdrawals of deposits, banks hold a precautionary buffer of reserves and government bonds. We show how monetary policy affects the banking system by altering the tradeoff between profiting from lending and incurring greater liquidity risk. We consider two applications of the theory, one involving the connection between the implementation of monetary policy and pass-through to loan rates, and another considering a quantitative decomposition behind the collapse in bank lending during the 2008 financial crisis. Our analysis underscores the importance of liquidity frictions and the functioning of interbank markets for the conduct of monetary policy.

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Document Object Identifier (DOI): 10.3386/w20490

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